Brazil’s Defense Spending Prompts Embraer To Change Tack

Embraer is a brand synonymous with commercial and business aviation, but can it also become one of the world's largest defense firms? The Brazilian aerospace company is repositioning itself to achieve that goal, and the catalyst for the move is a series of multibillion-dollar defense contracts that are coming up for grabs in Brazil.

There is Sisfron, a $6 billion integrated border-monitoring system that the Brazilian army plans to field to protect the nation's land frontiers. Brazil has borders with 10 different countries totaling nearly 17,000 km (10,560 mi.). There is also SisGAAz, otherwise known as “Blue Amazon,” a $2 billion project spearheaded by the navy to protect Brazil's exclusive economic zone. Brazil derives much of its economic wealth from its oil and gas platforms off the coast. The government also wants to protect its fisheries and ensure that it has the monitoring capability to stop any incursions. Another important program involves a geostationary satellite. It will have a payload for providing military communications.

In addition, there are defense and security contracts arising from the FIFA World Cup and Summer Olympics, which will be held in Brazil in 2014 and 2016, respectively.

The contracts require companies to have expertise in ground-based radar, sensors, air surveillance, satellite communications, Earth-observation and radio communications.

Embraer has made its defense and security business a separate entity and branded it Embraer Defesa e Seguranca (ED&S). Luiz Carlos Aguiar, who was previously Embraer's chief financial officer, is now ED&S's CEO.

“We are trying to emulate in Brazil what European and American defense companies have done in the past,” says Aguiar, referring to companies such as Boeing, which has defense and commercial/business aviation activities that are managed separately, each with its own CEO.

Even though Embraer already makes the Super Tucano light attack and the EMB-145 airborne early warning (AEW) aircraft, commercial and business aviation still accounts for 80% of Embraer's group revenue. However, a 20% revenue share in this year's first half is an achievement for ED&S, because last year Embraer's defense work amounted to only 15%. Aguiar anticipates ED&S will account for 25% by 2020. Last year the unit had revenue of $859 million; this year, it is forecast to be “a little over $1 billion,” he says. In 2006, Embraer's defense business had revenue of only $400 million, he adds.

ED&S is the world's 74th largest defense company, says Aguiar, and defense-sector consolidation in Europe and North America means that ED&S will rise in the rankings. Aguiar predicts that in 2020 ED&S's revenue will have more than doubled compared with 2012.

ED&S has boosted its revenues partly through acquisitions. It recently bought Orbisat, a maker of ground-based radar equipment, and Atech, a C4I (command, control, communications, computers and intelligence) specialist. ED&S also established Visiona, a joint venture with Brazilian state-owned telecommunications company Telebras. Visiona will spearhead the push into satellites and space technology. And ED&S has formed a joint venture with Israel's Elbit Systems to develop UAVs, specifically ones for border control.

One key motive behind the acquisitions, says Aguiar, is to garner the expertise and capabilities that ED&S needs to compete for new contracts. He says Embraer is interested in buying more defense companies, particularly ones with expertise in monitoring and surveillance. The preference, however, is for local rather than foreign acquisitions.

Orbisat and Atech are based in Brazil. One strategy for wooing Brazilian government decision-makers involves highlighting that ED&S is offering a locally developed product and ensuring that Brazil has the technology and capability to protect itself without relying on foreign entities. ED&S executives also say that because the technology has evolved locally, ED&S owns the intellectual property and, as a consequence, is free to market the systems overseas.

The strategy is apt because Brazil's multibillion-dollar defense contracts have caught the eye of other Brazilian companies, which are boosting their own expertise and capability by partnering with foreign defense manufacuturers.

Andrade Gutierrez, a Brazilian diversified conglomerate that started in construction and is now one of the country's largest companies, has established Andrade Gutierrez Defesa e Seguranca, a joint venture with Thales. The French entity owns 40%, while the Brazilian parent owns 60%. Orlando Neto, who previously headed Embraer's defense business, is Andrade Gutierrez Defesa e Seguranca's leader.

In the past, it could be assumed that the Brazilian government would automatically award contracts to Embraer; but that is no longer the case, as Embraer no longer a state-owned enterprise. The government owns only 0.3% of the company, although it has veto rights over activities via “golden” shares.

One upside of developing a defense business is that Embraer can benefit from government largesse and mitigate downturns in commercial and business aviation. It also means that some of Embraer's R&D costs are covered by the government.